Wave Theory
Wave theory is a form of technical analysis that looks for recurrent price patterns related to trader psychology.
Each set of waves is nested within a larger set of waves that follow the same pattern. These patterns emerge due to price trends largely being determined by investor psychology.
The theory suggests long-term upward price trends will consist of five waves before a long-term downtrend.
After the long-term downtrend has been completed, the cycle may repeat from point C.
The Five Waves:
- Impulse wave of initial excitement
- Corrective wave of A,B, C formation (as seen in figure 2)
- Strong impulse wave up to new highs
- Corrective wave of A,B, C formation (as seen in figure 2) 5. Smaller impulse wave to new highs (edited)
The corrective wave normally has three distinct price movements – two in the direction of the main correction (A and C) and one against it (B).
Waves 2 and 4 in the attached picture are corrections. These waves typically have a fractal ABC structure.
*Rules to remember*
1. Wave 3 shouldn’t ever be the shortest impulse wave.
2. Wave 2 shouldn’t ever go beyond the formation point of wave 1.
3. Wave 4 shouldn’t ever cross in the same price area as wave 1